Expecting a Weak Q2, But Likely a Buying Opportunity

It appears we are in the process of starting the first correction of the year; but, given recession risks remain a remote possibility and the long-term internals of the market remain sound, any correction in Q2 will likely prove to be a buying opportunity. A quick summary of the state of the economy and markets is provided below.

Economy Looks Solid

Philly Fed’s State Coincident Diffusion Index (Net % of states growing) is shown below in red along with the S&P 500 in black. Basically as long as it stays above 0%, recession risk is minimal and pullbacks are typically followed by new highs in the market.

Source: Bloomberg

Here, we see the S&P 500 shown alongside initial jobless claims (inverted for directional similarity). Jobless claims confirmed the new high in the market by hitting a new low. This is significant as jobless claims usually diverge at major peaks with the market.

Source: Bloomberg

Corporate Bond Market Showing Stress, Not Yet Present in Stock Market

Chart below shows high yield bond prices with the S&P 500. High yield bond prices typically peak before the market (see yellow boxes below). Last week they spiked down, which suggests a pullback.

Source: Bloomberg

Indicators Suggesting Q2 Correction

Next chart shows the relative performance of early to late-stage cyclicals, which typically leads the market by 6-9 months. Current data suggests we see a correction beginning this month and lasting through May (see blue box below).

Source: Bloomberg

The chart below shows oil prices (red line) advanced and inverted relative to the S&P 500's price appreciation (blue) and the Citigroup Economic Surprise Index (black line) for major economies. Past spikes in oil suggest rising inflation should spill over into the economy slowing growth and corporate earnings. Consequently, the stock market may disappoint between April 12th and May 31st.

Source: Bloomberg

Weakening Breadth and Momentum

Below is a chart of the S&P 500 and various breadth measures of the 500 stocks within the index which are showing negative divergences with the price action in the S&P 500, which typically occurs prior to a pullback.

2nd Panel – Shows % of members above moving averages

% Above 20d SMA diverging and falling sharply as it did prior to last two pullbacks

% of stocks with strong momentum ( > 70) fading as it did prior to November 2012 correction

4th Panel – Members hitting 3-month new highs/lows

% of stocks hitting 3-month new highs diverging with price.

6th Panel - % Members with MACD above 0

Not yet below 70% which often markets intermediate sell signals but is diverging with price

Source: Bloomberg

Summary

While several leading indicators and weakening market breadth suggests that we could have a pullback in Q2, given the state of the economy and long-term technicals of the market remain healthy, any correction that develops is likely to be a buying opportunity.